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EIU global forecast - market turmoil signals slowing growth

January 18th 2019 | Saudi Arabia | Retail

Financial markets entered 2019 in turmoil. The US markets, where investors have become uneasy as signs of slowing growth have emerged, saw significant episodes of volatility as they reacted to a string of negative events. US markets became concerned after the Federal Reserve (Fed, the central bank) raised rates on December 19th, for the fourth time in 2018, and signalled further increases in 2019. In a move to calm the markets, Jerome Powell, the Fed chairman, indicated that, with subdued inflationary pressures, the Fed could take a "patient" approach to raising rates further. US markets were also rattled by signs of weakness in corporate earnings as Apple (a US multinational technology company) warned that fourth-quarter revenue would not reach expectations owing to weak sales in emerging markets, especially China. Given market volatility and the negative effects of the US-China trade war, there is a growing likelihood that the Fed will raise rates only once this year, if at all. In December The Economist Intelligence Unit revised its US monetary policy forecast to two rate rises in 2019 rather than the three that it had previously expected. This continues to be our forecast, as Fed policy decisions remain data-dependent and the current state of the US economy is still very healthy. In December the economy added 312,000 jobs, nominal wages grew by 3.2% compared with the year-earlier period and more workers joined the workforce, attracted by the strength of the labour market. Nonetheless, we expect global markets to experience further bouts of volatility as the global economy adjusts to a slower growth path and uncertainty over the trade war continues; and the risk is tilted towards fewer rather than more rate increases. On balance, we expect the global economy to slow to 2.8% in 2019, down from 3% in 2018.

In 2018 the world's two largest economies, the US and China, became embroiled in a trade war, the impact of which will weigh on global growth in 2019. On January 9th bond markets responded positively as investors eyed developments in the first round of US-China negotiations since a truce was declared after the US president, Donald Trump, met with China's president, Xi Jinping, on the sidelines of the G20 summit in Argentina. Signalling the seriousness of the Chinese side in finding a resolution to the dispute, the most recent talks also saw unexpected attendance by the Chinese vice-premier, Liu He, on the first day of negotiations. Mr Liu's presence broke with preferred diplomatic protocol, in that similar-ranking members of the US delegation were not also present in the room. The discussions did not lead to any immediate breakthrough, however, with both sides releasing separate vague statements after the negotiations concluded. We continue to expect that the US and China will be unable to strike a deal by March 1st to prevent further escalation in the bilateral trade war. Although a deal between the two countries cannot be ruled out, it is likely to be limited in nature. In particular, it will not materially address the fundamental issues of concern to the US, such as forced technology transfer and intellectual property protections. Consequently, we would expect the deal to be short-lived and trade tensions to endure in the forecast period. In 2019, as a result of the trade war, a maturing business cycle and the waning impact of tax cuts, we expect the US economy to slow to 2.3%, from an estimated 2.9% in 2018, and China's economy to slow to 6.3% from an estimated 6.6% in 2018 (this forecast assumes limited economic stimulus by the Chinese government).

The outlook for growth in other major economies varies as the weakening external environment interacts with differing domestic circumstances. In Japan, growth is set to accelerate modestly in 2019 as consumers rush to beat an anticipated rise in the country's consumption tax rate in October 2019. Elsewhere in Asia, India's economy will maintain a robust growth rate above 7% in 2019 as the economy benefits from the increasing emergence of middle-class consumer spending. Brazil's economy continues to recover from a deep recession in 2015‑16, with a post-election pick-up in investment and private consumption pushing growth to 2.5% in 2019, from a modest 1.2% in 2018. Brazil's recovery will, however, be constrained by the headwinds facing many emerging markets in 2019, including the US-China trade war, a stronger US dollar and tighter financing conditions. The US-China trade war has also begun to weigh on Germany's economy, as both exports and imports struggled in November. With industrial production also contracting in November, we now expect the EU's biggest economy to grow by just 1.2% this year (1.6% previously).

Resignation of US defence secretary will have global ramifications

On December 20th the US defence secretary, James Mattis, resigned, citing opposing views to those of Mr Trump. Mr Trump has long thought that ongoing trade deficits signal that the US is losing from international trade, and has seen little value in the US alliance system that has been developed since the end of the second world war. We expect his stance on these issues to harden in 2019, given the increasing domestic pressure that will result from a slowing economy, the completion of the Special Counsel investigation into possible links between the Trump campaign and Russia, and increased scrutiny from congressional Democrats who now form the majority in the House of Representatives, the lower house of the US Congress. The departure of Mr Mattis from the administration removes a major constraint on Mr Trump's ability to put his personal stamp on US foreign policy.

A good example of how Mr Trump's agenda was previously watered down is the National Security Strategy released in December 2017. This managed the difficult task of incorporating Mr Trump's mantra of "America First" into a framework that was similar to that of previous administrations, naming Russia and China as strategic competitors but expressing support for traditional US allies. As such, this document was fundamentally at odds with Mr Trump's ideological preferences. In future, Mr Trump is likely to become bolder in trying to shift foreign policy in his direction. However, although he will face less resistance from within his administration, Mr Trump will continue to clash with other parts of the US government. This will inject an ongoing element of volatility into US foreign policy as officials attempt to dilute some of Mr Trump's initiatives. As an early warning of how this tension will play out, the US policy on Syria is indicative. On December 19th Mr Trump announced that he had decided to withdraw US troops from Syria because their principal mission, the defeat of Islamic State, had been—in his view—accomplished. At the time of the announcement, the decision was said to be effective within the next 100 days. There is now some uncertainty over this timeline after John Bolton, the US national security adviser, indicated that the troop withdrawal was conditional on the safety of Syrian Kurds. This pattern of behaviour is likely to be repeated, especially if, for example, Mr Trump repudiates NATO's Article 5—the alliance's principle of collective defence that states that an attack on one member represents an attack on all—or signals his intention to withdraw US troops in an allied position, such as South Korea.